Will the Shield Protecting Terrorism Insurers Be Lifted?

With the Terrorism Risk Insurance Act (TRIA) set to expire by the end of 2005, real estate lenders and owners are voicing their concern that if the federal backstop isn't extended, primary insurers could drop terror coverage entirely, or raise their premiums to incredibly high levels.

Some critical dates are looming. Treasury Secretary John Snow has until Sept. 1, 2004, to extend TRIA's “make available” provision for a one-year period. This important measure underpinning TRIA demands that insurers offer terror coverage to their property and casualty policyholders.

The federal backstop, however, doesn't officially expire until Dec. 31, 2005, so the government will continue to cover insurers' losses until then. Still, insurers could begin excluding coverage by Dec. 31 if the Treasury Secretary doesn't renew the provision.

In effect, supporters of TRIA — which is widely credited for stabilizing the terror insurance market — fear the industry could revert back to the dark days immediately following 9/11 when insurers roundly excluded such coverage from their policies.

“Uncertainty is already creeping into the insurance marketplace, and that's not the kind of thing that real estate investors need,” says Robert Hartwig, chief economist at the Insurance Information Institute, an influential trade group. “The insurers just can't go it alone.”

Rising Tide Of User Demand

TRIA was crafted to expire after a three-year duration. The hope was that a private reinsurance market would emerge to cover the primary insurers' losses after a major terror attack. While that has yet to happen, TRIA has largely succeeded at bringing affordable coverage to those who need it most.

According to Marsh Inc., a major U.S insurer, the percentage of firms renewing their insurance policies that added terror insurance coverage remained relatively flat during the second and third quarter of 2003. In a survey of 2,400 organizations with P&C insurance, Marsh found that roughly one-quarter of renewing policyholders chose to buy terrorism coverage during those two quarters (see chart).

However, the fourth quarter of 2003 saw a 32.7% acceptance rate (also known as a “take-up rate” in insurer parlance) for all companies renewing their policies. Marsh partly attributes this increase to declining prices. In fact, median pricing for terror coverage dropped 42% in the second half of 2003.

So, who's buying? Among the largest groups of policyholders buying terror coverage during the last three quarters of 2003 were the energy, media, food and beverage, hospitality, healthcare and real estate industries. Demand for terror coverage was also highest in the Northeast, home to both Washington, D.C., and New York City. The lowest demand was in the western U.S.

Triage For TRIA

The Marsh analysis projects that any event that triggers coverage under TRIA between now and the end of 2005 could become a critical factor in the ultimate decision to renew TRIA. That's because the market for stand-alone terrorism coverage is “fairly limited and somewhat fragile,” according to Marsh. A certified attack between now and then could cause the market to simply restrict coverage, or increase premiums. It could also persuade underwriters to stop writing the coverage altogether

“When the law was passed in 2002, it was designed to foster a private market for this coverage,” says Bob Vestewig, COO at GEMSA Loan Services, a commercial mortgage-backed securities (CMBS) servicing firm based in Houston. “There is an understanding that this is a needed product, but this is an election year, which makes it harder to focus on,” says Vestewig. He notes that quotes for terror insurance coverage have dropped since last year, which he says is proof that “the law is working.”

But the future of that law is hardly certain. The passage of TRIA was heavily debated in 2002 — and Marsh believes that is a harbinger of things to come. The Treasury Department has also insisted for many months that it would oppose extending the Act.

Although a poll of insurance brokers shows that fewer than 20% of their clients have bought coverage under TRIA, commercial real estate lobbyists are still urging Treasury Secretary Snow to extend the Act. In a letter dated March 12, the president of the Real Estate Roundtable, Jeffrey DeBoer, stated his case to Secretary Snow.

“There is little evidence that private insurance markets have stabilized. In fact, in those areas where there is no existing mandate that insurers offer coverage — non-certified, domestic terrorist attacks; attacks involving chemical, biological or radiological attacks; and, reinsurance for the retained losses of primary insurers — no meaningful private market has developed at all,” reads an excerpt from DeBoer's letter.

The reinsurance industry is clearly worried about covering huge losses inflicted by spectacular terror attacks in the future. It also is fully aware that reinsurance firms forked over 55% of the losses incurred on 9/11, which were estimated at $40 billion.

AIG, the world's largest insurer, also is hoping for an extension of TRIA. Richard Thomas, senior vice president and chief underwriting officer at AIG, believes that the prospect of no government backstop by 2006 will force many insurers to change their behavior toward this risk.

“There are simply too many types of attacks that exceed the amount of money that insurers can offer. The industry is prepared to insure against this, but absent any federal protection many insurers will exclude it,” he says. Thomas adds that AIG is now working with Capitol Hill on extending the Act.

Undeveloped Market for Coverage

Indeed, the president of the Council of Insurance Agents and Brokers, an industry trade group, believes the insurance marketplace is largely driven by the requirements of the law rather than a greater capacity for terrorism coverage.

“Because negotiations over renewals for large accounts typically begin several months before the policy renewal date, we could start seeing the impact of the expiration of TRIA as early as this fall for January 2005 renewals,” says Ken Crerar, council president.

He believes lawmakers should consider that some carriers might choose not to renew a yearly contract on a high-profile property if TRIA is set to expire in months. Says Crerar: “There would be no federal protection in the event of a terrorist attack.”

There may be little that owners and lenders can do now other than wait, but by the end of this year they will begin to renegotiate 2005 contracts with their insurers. “At the end of 2004, contracts will start to include this new language if insurers fear that it [TRIA] won't be renewed,” says Hartwig of the Insurance Information Institute.

Rich Chicotel, CFO at San Francisco-based Shorenstein Co., isn't expecting the government to renew TRIA. He does admit that “things were a lot harder without TRIA” immediately after 9/11. Shorenstein, a privately held company, owns and operates more than 22 million sq. ft. of Class-A office space throughout the nation.

Chicotel, who bought stand-alone terror coverage for the firm last year, says that pricing has come down since last year. In fact, he just renewed his terror coverage on April 1.

When asked if Shorenstein bought terror coverage under duress from lenders, Chicotel says it was a mutual decision. “We have a shared interest with our lenders regarding this coverage, and that makes it important for both of us,” he says.

Insurers Plan for the Worst

TRIA's life span is finite, but the chances of repeat terror attacks on U.S. soil are infinite. Foreign events only underscore that threat, as the March train bombings in Madrid, Spain proved. Fears have hardly quelled since then. In early April, the federal government warned of a Madrid-type attack unfolding in the U.S. this summer.

While owners continue to assess the potential vulnerability of their assets to a terrorism attack, some lenders have created guidelines that spell out how they plan to underwrite properties. Other lenders have responded on a case-by-case basis to determine if they will demand terror insurance for a particular property and the extent of that coverage.

AIR Worldwide, a Massachusetts-based risk-modeling firm, uses a slew of factors to gauge a property's chances of being targeted by a terrorist attack. AIR identified more than 300,000 potential targets, among them many commercial real estate assets scattered across the U.S. The firm also singled out “trophy” targets that pose a higher threat of being attacked.

The AIR database is updated twice a year. Much of its recent work has been with owners of high-profile buildings in places such as Manhattan. “We are seeing plenty of demand from risk managers with high-profile assets. We can assess what potential loss scenarios could occur to that particular property,” says S. Ming Lee, senior vice president at AIR.

The AIR model analyzes threats posed by a wide variety of domestic and international terrorist groups. It then considers damage from a wide array of conventional weapons, including bombs and hijacked airplanes. The effects of unconventional weapons such as chemical, biological, radiological and nuclear are also built into AIR's risk model.

For example, if a truck bomb were to detonate in Manhattan it would damage 29 buildings within the blast zone. Roughly 2,500 people would be killed and 25,000 would be injured. The estimated property loss from such an attack would run about $3 billion to $4 billion, according to AIR, and the estimated workers' compensation loss would be even higher at $4 billion to $5 billion. These are all simulated losses calculated by AIR risk modeling software.

“Building owners are coming to us and asking how their buildings stack up to other buildings in terms of risk,” adds Lee. AIR has modeled hundreds of thousands of scenarios.

Regardless of the threat, responsibility for TRIA ultimately lies with the federal government. And there's no clear indication that the government will renew this legislation. “I doubt that the government will renew TRIA. The market will take care of itself,” says Susan Merrick, managing director at Fitch Ratings.

Merrick says landlords with vulnerable portfolios such as Boston Properties and Vornado Realty Trust have bought adequate terror insurance over the past year. Boston Properties declined to comment on its terror coverage, as did Vornado. Merrick believes that this wouldn't have been possible if a private market for coverage had not already formed.

“They bought the coverage at what sounded like realistic rates,” says Merrick. “The price for this coverage has already come down from where it was, and I believe that price will come down more.”